GDP– Measuring Total Production and Income

Taking the Nation’s Pulse

Chapter 8

• Gross Domestic Product (GDP): The market value of final goods and services produced within a country during a specific time period, usually a year.

GDP vs GNP??

• GDP: production within a country’s borders (domestic)

• GNP: production by people of a country (national)

Stage of productionValue added to the product (equals income created)

Sales Receipts(at each stage of production)

Stage 1: farmer’s wheat

Stage 2: miller’s flour

Stage 3: baker’s bread(wholesale)

Stage 4: grocer’s bread (retail)

$.30

$.65

$.90

$1

by farmer$.30

by grocer$.10

by miller$.35

by baker$.25

• What Does Not Count Toward GDP?•Sales at intermediate stages of production. Their

value is already counted in the final-user good. Including them would result in double counting.

Total consumer expenditure = $1 Total value added = $1

Only final goods and services countOnly final goods and services count

• What Else? • Financial transactions and income transfers.

They do not reflect production.

• Production outside the geographicborders of the country is not counted.

• Goods not produced during the current period are not counted.

Stocks

1955 Chevy

Which are included in this year's GDP? :

• 1. Interest on an AT&T bond - • 2. Social Security payments to retirees -• 3. Services of a painter in painting a house - • 4. Income of a dentist -• 5. Money received from the sale of a 1990 model car- • 6. Monthly allowance of a college student -• 7. Rent for a 2 bedroom apartment -• 8. Money received for selling this year's model car - • 9. Interest on a government bond -

YES

YESNONO

YES

YESYE

SYES

YES

YES YE

SYES

NONO

NONO

NONO

Which?

• 10. A two hour decline in the work week -• 11. Purchase of the AT&T bond -• 12. A $ 2 billion increase in business investments -• 13. Purchasing 100 shares of GM common stock -• 14. Purchase of an insurance policy -• 15. Wages paid to your butler -• 16. Market value of a homemaker's services -• 17. Purchase of the Mona Lisa -

NONO

YES

YES

YES

YESYE

SYES

NONO

NONO

NONO

NONO

• GDP is measured in dollars• Each good produced increases output

by the amount the purchaser pays for the good.

GDP is the sum of total spending on all goods and services produced during the year.

Two Ways of Measuring GDP

Three

ncomesxpenditures

OI

utput (Value Added)

E

• 1. Expenditure Approach:• GDP is the sum of expenditures on final user

goods and services purchased by households, investors, governments, and foreigners.

• There are four components of GDP: •personal consumption purchases C•gross private investment Ig

(including inventories) •government purchases G

(consumption and investment)•net exports ( exports minus imports ) Xn

GDPDollar flow ofexpenditureson final goods

=Dollar flow of

income (and indirect cost) of final goods

=

Measuring GDP

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Figure 8.2 Components of GDP in 2010

Consumption accounts for 70.5 percent of GDP, far more than any of the other components.

In recent years, net exports typically have been negative, which reduces GDP. .

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Will U.S. Consumers Be Spending Less?

Although it can be good news for the economy in the long run, the determination

of U.S. households to cut back on spending and

increase saving in 2011 may partly explain the slow

recovery from the 2007–2009 recession.

Consumption is a larger fraction

of GDP in the United States than in most other high-

income countries or in rapidly growing countries such as

China and India.

Over time, consumption in the United States has increased

as a fraction of GDP.

• 2. Resource Cost - Income Approach

Sum of these = national income

• GDP is the sum of costs incurred and income (including profits) generated by production of goods and services during the period.

a. The direct cost income components of GDP:•employee compensation Labor•self-employment income

labor/entrepreneur •rents land• Interest capital•corporate profit entrepreneur

• 2. Resource Cost - Income Approach: (cont.)

Not covered

+ national income (employee compensation, self-employment income, rents, interest, corporate profit)

+ indirect business taxes + depreciation + net income of foreigners

• When derived by Resource Cost - Income Approach, GDP is equal to:

• 3. Output – by Industry (Value Added)

• Add up output by each industrial sector

• Chemicals + Agriculture + …

Stage of productionValue added to the product (equals income created)

Sales Receipts(at each stage of production)

Stage 1: farmer’s wheat

Stage 2: miller’s flour

Stage 3: baker’s bread(wholesale)

Stage 4: grocer’s bread (retail)

$.30

$.65

$.90

$1

by farmer$.30

by grocer$.10

by miller$.35

by baker$.25

Total consumer expenditure = $1 Total value added = $1

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Firm Value of Product Value Added

Cotton farmer Value of raw cotton = $1 Value added by cotton farmer = 1

Textile mill Value of raw cotton woven into cotton fabric = $3

Value added by cotton textile mill = ($3 − $1)

= 2

Shirt company Value of cotton fabric made into a shirt = $15

Value added by shirt manufacturer = ($15 − $3)

= 12

L.L.Bean Value of shirt for sale on L.L.Bean’s Web site = $35

Value added by L.L.Bean = ($35 − $15)

= 20

Total Value Added = $35

Measuring GDP Using the Value-Added Method

Value added The market value a firm adds to a product.

Calculating Value Added

The price of the shirt on L.L.Bean’s Web site is exactly equal to the sum of the value added by each firm involved in the production of the shirt.

• Shortcomings of GDP:• It does not count non-market production. • It does not count the underground economy.• It makes no adjustment for leisure.• It probably understates output increases

because of the problem of estimating improvements in the quality of products.

• It does not adjust for harmful side effects.• It does not consider standard of living – GDP

per person• Great contribution of GDP:

• In spite of its shortcomings, real GDP is a reasonably accurate measure of short-term fluctuations in output.

• The term "real" means adjusted for inflation. • Price indexes are use to adjust data for

inflation. • A price index measures the cost of

purchasing a good (or goods) at a point in time relative to the cost of purchasing the identical good during an earlier (or base) period.

Year $ Spending Index

1 170 _____

2 180 _____

3 Base year 200 _____

4 200 _____

5 224 _____

6 250 _____

7 280 _____

Year $ Spending Index

1 170 _____

2 180 _____

3 Base year 200 _____

4 200 _____

5 224 _____

6 250 _____

7 280 _____

Current year spendingBase year spending

x 100

Creating a price indexCreating a price index

• measures the impact of price changes on the cost of a typical bundle of goods and services purchased by households.

• designed to measure the change in the average price of the market basket of goods included in GDP (a broader price index than the CPI).

2. WPI2. WPI

1. PPI1. PPI

3. MPI3. MPI

Real GDP2 = Nominal GDP2 * GDP Deflator1

GDP Deflator2

• Data on both money GDP and price changes are essential for meaningful comparisons of output between two time periods.

• The formula for converting the nominal GDP into real GDP is:

Converting Earlier Figures to Current Dollars

• For comparisons across time periods, we must use current dollars.

• Done by “inflating” the earlier data for the increase in the price level.

• The formula:

Figurecurrent $ = Figureearlier $ * price indexcurrent year

price indexearlier year

• This will “inflate” the data for earlier years into line with the current purchasing power of the $.

Gross Domestic Product

Complete the following table assuming that Year 1 is the base year.

Year Output Price Money GDP

GDP Index

Real GDP

1 100 $4.00

2 120 4.40

3 110 5.00

4 110 5.20

5 135 5.20

6 140 5.60

Gross Domestic Product

Complete the following table assuming that Year 1 is the base year.

Year Output Price Money GDP

GDP Index

Real GDP

1 100 $4.00 $400 100 $400

2 120 4.40 528 110 480

3 110 5.00 550 125 440

4 110 5.20 572 130 440

5 135 5.20 702 130 540

6 140 5.60 784 140 560

• Gross National Product (GNP): Output by the “nationals” – citizens of the country, regardless of whether that output is produced domestically or abroad.

• National income: Income earned by the nationals (citizens) during a period. It is the sum of employee compensation, self-employment income, rents, interest, and corporate profits. Minus depreciation and taxes

• Personal income: Income received by domestic households and non-corporate businesses. It is available for consumption, saving, and personal taxes. Includes transfers.

• Disposable income: Income available to individuals after personal taxes. Can be spent on consumption or saved.

Source: U.S. Department of Commerce.

1996 2001 % increase

Nominal GDP(billions of U.S. $)

Real GDP(billions of 1996 $)

$7,813 $10,208 30.7%

Price index (GDP deflator, 1996 = 100)

100.0 109.4 9.4%

$7,813 $9,331 19.4%

Deriving Real GDP

Like “Deflating” the $

Source: http://www.economagic.com.

1998 2003 % increase

Nominal GDP(billions of U.S. $)

Real GDP(billions of 1998 $)

$8,747 $11,004 25.8%

Price index (GDP deflator, 2000 = 100)

96.5 106.0 9.8%

$8,747 $10,018 14.5%

Source: http://www.economagic.com.

20002006% increase

Nominal GDP(billions of U.S. $)

Real GDP(billions of 2000 $)

$9,817 $13,247 34.9%

Price index (GDP deflator, 2000 = 100)

100.0 116.0

16.0%

$9,817 $11,420 16.3%

Interesting Questions 1. The CPI was 177 in 2001 compared to 100 in 1983.

Suppose that the price of a ticket at a local movie theater rose from $4 to $8 between 1983 and 2001. Did the real ticket price increase or decrease? Calculate the 1983 ticket price measured in 2001 dollars.

2. The CPI was 210 in 2007 compared to 100 in 1983. Suppose that the price of a ticket at a local movie theater rose from $4 to $8 between 1983 and 2007. Did the real ticket price increase or decrease? Calculate the 1983 ticket price measured in 2007 dollars.

GDP ComparisonsAcross Time Periods and Across Countries

1. Which of the following activities will affect GDP:a. You pay $600 per month to lease an apartment.b. You pay $8,000 to purchase a four-year-old car.c. You have car trouble and have to pay a repair shop

$1,500 to fix the transmission of your car.d. You pay $5,100 to purchase 100 shares of Microsoft

stock ($50 per share for the stock plus a $100 fee).e. You sell your 100 shares of Microsoft stock

(purchased for $5,000) for $6,000 minus a $100 brokerage fee.

f. Your aunt sends you $500 to help with your expenses.

g. You earn $500 providing computer services for a faculty member.

h. You win $500 playing cards with classmates.